The liquidators of Feltex are claiming more than $12 million from auditors Ernst & Young, arguing that the firm breached the terms of its contract, and the duty of care and skill that it owed the failed carpet maker.

That breach of contract caused Feltex to breach its listing rules, mislead the market and be liable to shareholders who invested during the period of breach, liquidators Peri Finnigan and Iain McLennan of McDonald Vague say in their statement of claim filed last November, court documents show.

Thousands of shareholders invested $250 million in Feltex when it listed on the NZX in June 2004. Two years later it was placed in receivership, then liquidation and shareholders lost their entire investment.

In August 2010, the directors of Feltex were charged in Auckland District Court with misleading investors.

The charges related to Feltex's December 31, 2005 half-year financial statements which did not disclose that the company had breached the terms of its bank debt and did not properly classify debt to ANZ as "current liabilities", meaning the bank had the right to call them in on 30 days' notice.

Feltex directors John Feeney, John Hagen, Peter Hunter, Tim Saunders and Peter Thomas successfully defended the charges by arguing they had taken all reasonable steps to ensure compliance, and they had been assured by accounting firm Ernst & Young that the reports were adequate.

The directors were acquitted and the judge said they had been entitled to rely on professional advice.

Now the liquidators are pursuing the auditors who gave that professional advice, claiming $5,981,503 from Ernst & Young New Zealand, and $6,048,670 million from Ernst & Young Australia, plus interest and costs.

Ernst & Young failed to alert Feltex that it needed to disclose the breach of its terms of bank debt and that it had to be classified in its accounts as current liabilities, the liquidators claim. They also argue that the auditors failed to ask the company enough, or any, questions about the banking arrangements to be able to comply with their duty, and Feltex's resulting liability to shareholders was caused by Ernst & Young's failures.

However, the audit firm denies it is to blame. The fault, it says, lies with Feltex, which failed in the duty that it owed Ernst & Young by not giving it all the relevant information.

Ernst & Young New Zealand also says its contract with Feltex limited its liability to about $300,000, and Ernst & Young Australia says the contract expressly excluded it from any legal action arising from the review.

Both say if they were at fault at all, then Feltex was also partly to blame because it did not supply relevant information.

They are also challenging whether the liquidators can really claim the loss as shareholder losses, when any damages may be payable to Feltex's secured creditor, ANZ.

- © Fairfax NZ News